## What is the utilization ratio?

The utilization rate is an important ratio that **companies** can use to determine what to charge their clients. The ratios are used to maximize the productivity time for employees. As we all know, time is money, so the more productive your team is, the more money you can effectively make. It can reflect the effectiveness of billing and the overall **productivity** of the company. There are two different types of methods used in bookkeeping for calculating indirect and direct labor **expense** utilization ratios.

## Method one

The first method is used for calculating the total **billable hours** divided by the number of hours recorded in a particular period. For example, if the total hours are 60 but the hours billable are 30, then the utilization rate would be 30/60 = 50%. Using this utilization ratio, if the company is willing to cease recording their **non-billable time,** the ratio will always be equal to 100%.

## Method two

The second method used for calculating the **labor** utilization rate uses the total hours billable divided by a fixed number of hours for each week. An example will help elaborate this formula. If there are 22 **billable hours** recorded in a predetermined 40 hours per week, then the utilization ratio will be **calculated** as 22/40 = 55%.

## Why are labor utilization ratios important?

Company leaders rely on utilization ratios to significantly **identify** how much of the company’s workforce is currently employed and productive. It provides how the current workforce is performing and the required performance from current **employees.** If the ratio indicates an overproduction, then the company must hire more people to improve and balance productivity based on **utilization rates.**

## Direct labor utilization

A company’s payroll is considered the most considerable **organizational** expense. Companies want to make sure that their payroll costs are generating sufficient income. The direct labor utilization ratio indicates how much a company is **spending** each year on direct labor.

The remainder of payroll-associated costs is considered **indirect labor costs.** Examples of indirect labor costs are:

- Amount spent on
**training**employees - Administrative expenses
- Marketing
**expenses** - Paid vacations
- Taxes

## How to calculate the direct labor utilization ratio

The calculation needed for the direct labor utilization ratio includes dividing the total **payroll amount** associated with direct labor by the total cost of payroll for that specific period which will give the direct utilization ratio. For example, suppose your **company** is spending $4,000 on the payroll for a specific pay period and pays an additional $3,000 in direct labor expenses. In that case, the utilization ratio for **direct labor** is 75%. (3,000/4,000 = 75%)

On average, the direct labor utilization ratio must be around 65%. A value higher than 65% will indicate that the company is **utilizing** its labor force efficiently. Companies that have fewer paid vacations and paid training will have a lower utilization cost.

## Indirect labor utilization

Overhead costs are also called indirect labor costs. Labor **overhead costs** are directly associated with the different materials used for direct labor. Calculating indirect labor utilization is different, and here’s what we need:

- The number of hours an employee has worked: if the
**employee**worked for 52 weeks per year * 40 hours per week, then he/she worked for almost 2,080 hours. - Deduct the total time spent on holidays per year: 45 days or 360 hours (including sick leaves, public holidays,
**training,**and seminars) 360 – 2,080 =1,720 hours.

Hence, the 1,720 hours are our total hours spent by one employee as **indirect labor** utilization.

## All in all

Using the utilization **ratio** is the best way to calculate labor and labor cost. The information above will help you decide if you should use a direct or an indirect **formula** for your business.

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